Query No. 3

Subject:

Accounting for work-in-progress of closed jobs towards amount receivable from the

clients against extra work and other claims not certified or accepted by the clients.¹

A. Facts of the Case

1. A company’s major activity is project construction work which constitutes 93% of the total revenue. The company is following the method of valuation of work-in-progress comprising the following amounts:

(i) Value of Running Account Bills for work done up to the year end for which payments have not been received from the clients.

(ii) Estimated value of work executed for which bills have not been raised pending measurement of work done.

(iii) Extra work executed for which bills have been raised but not settled by the clients.

(iv) Value of escalation of costs for which bills have been raised but not settled by the clients.

2. The querist has stated that the company is consistently following a conservative policy of revenue recognition and valuation of work-in- progress, after making suitable adjustments following ‘Cost to Complete’ basis as per the Accounting Standard (AS) 7, ‘Construction Contracts’, issued by the Institute of Chartered Accountants of India.

3. According to the querist, in case of closed jobs, where extra/ substituted work and other claims are not certified or accepted by the clients by the year end, the company makes a conservative and realistic estimate of the amount receivable from the clients and takes it as work-in-progress. This is done to match costs with the revenue. While all costs incurred for such work are booked in the year in which the expenditure is incurred, corresponding revenue is also taken into consideration for closed jobs on a conservative basis.

B. Query

4. The querist has raised the following issues for the opinion of the Expert Advisory Committee:

(a) Whether the method of accounting followed in respect of closed jobs can be improved in the light of the generally accepted accounting principles, the   company’s declared accounting policies and AS 7.

 

(b) Also mention the appropriate method of disclosure of these accounting policies and reflection in the profit and loss account.

C. Points considered by the Committee

5. The Committee notes that Accounting Standard (AS) 7 (revised 2002), ‘Construction Contracts’, issued by the Institute of Chartered Accountants of India, requires in paragraph 21, that “contract revenue and contract costs associated with the construction contract should be recognised as revenue and expenses respectively by reference to the stage of completion of the contract activity at the reporting date”. The Committee further notes that paragraph 24 of AS 7 (revised 2002) states that “the recognition of revenue and expenses by reference to the stage of completion of a contract is often referred to as the percentage of completion method”.

6. From the above, the Committee is of the view that AS 7 (revised 2002) does not recognise the ‘cost to complete’ method as stated by the querist in paragraph 2 above as being followed by the company.

7. The Committee notes paragraphs 24, 25 and 26 of AS 7 (revised 2002), which provide as below:

“24. The recognition of revenue and expenses by reference to the stage of completion of a contract is often referred to as the percentage of completion method. Under this method, contract revenue is matched with the contract costs incurred in reaching the stage of completion, resulting in the reporting of revenue, expenses and profit which can be attributed to the proportion of work completed. This method provides useful information on the extent of contract activity and performance during a period.

25. Under the percentage of completion method, contract revenue is recognised as revenue in the statement of profit and loss in the accounting periods in which the work is performed. Contract costs are usually recognised as an expense in the statement of profit and loss in the accounting periods in which the work to which they relate is performed. However, any expected excess of total contract costs over total contract revenue for the contract is recognised as an expense immediately in accordance with paragraph 35.

26. A contractor may have incurred contract costs that relate to future activity on the contract. Such contract costs are recognised as an asset provided it is probable that they will be recovered. Such costs represent an amount due from the customer and are often classified as contract work in progress.”

8. From the above, the Committee is of the view that under the percentage of completion method of recognition of revenue from construction contracts, revenue is recognised on the basis of stage of completion rather than on the basis of the mere fact that whether or not payment has been received or settled. Work-in-progress can be recognised only in respect of costs incurred by an enterprise that relate to future activity on the contract, provided they are capable of recovery. For example, an enterprise might have bought construction material which will be used in future for completing the contract. The Committee, however, notes from the facts of the case that the company is treating even the costs that relate to construction activities completed during the year as work-in-progress, e.g., in respect of bills not raised or bills raised but not settled. The Committee is of the view that the amounts presently recognised as work-in-progress including extra/substituted work and other claims not certified or accepted by clients, should be considered as ‘revenue’, subject to the requirements of AS 7 particularly those contained in paragraph 10 of AS 7 (revised 2002), reproduced below:

     “10. Contract revenue should comprise:

       (a) the initial amount of revenue agreed in the contract; and

 

       (b) variations in contract work, claims and incentive payments:

 

       (i) to the extent that it is probable that they will result in revenue; and

       (ii) they are capable of being reliably measured.”

9. In view of the above, the company should modify its accounting policy appropriately and make disclosures as per paragraphs 38 to 44 as illustrated in the Appendix to AS 7 (revised 2002).

D. Opinion

10. On the basis of the above, the opinion of the Committee on issues raised in paragraph 4 above is as below:

(a) The method of accounting followed should be changed as suggested in paragraph 8 above.

(b) The accounting policy should be disclosed under the ‘significant accounting policies’ forming part of the financial statements. The amounts presently recognised as work-in-progress should be shown as ‘revenue’ in the profit and loss account, subject to the requirements of AS 7.

¹ Opinion finalised by the Committee on 15.3.2005